Sprint Misses Estimates, But Performs Well Where It Counts

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Sprint (NYSE:S), the fourth largest U.S. wireless carrier, posted a wider-than-expected fiscal second quarter loss, weighed down by higher promotional spending and postpaid phone subscriber losses from prior periods. Although the carrier continues to walk a tightrope of sorts, balancing a tough financial position with the sizable network and subscriber investments required to drive growth, it actually performed fairly well in many key areas during Q2. For instance, the carrier posted its first set of postpaid phone net subscriber additions in more than two years, while continuing to improve its average billing per user (ABPU). [1] Moreover, the carrier is doubling down on its restructuring activities, targeting run rate operating cost reductions of $2 billion by the end of 2016. In this note, we take a look at some of the key takeaways from Sprint’s Q2 earnings and how they could impact the carrier going forward.

We have a $5 price estimate for Sprint, which is roughly in line with the current market price. We will be revisiting our estimates to account for the earnings release.

See our complete analysis for  AT&TVerizonSprint

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Postpaid Adds, ABPU Growth 

The first and most important step of Sprint’s turnaround plan is to stop subscriber losses, and the carrier did well in this regard, as lucrative postpaid phone net additions stood at 237,000, compared to losses of 500,000 for the year-ago period. While the number was largely driven by migrations from the carrier’s prepaid base, postpaid new phone net additions (excluding prepaid migrations) stood at 38,000, marking a solid improvement of 538,000 year-over-year. The carrier also posted its best-ever Sprint platform postpaid churn of 1.54%, marking a 64 basis point year-over-year improvement, driven by better credit quality of recently acquired customers and network improvements (discussed below). Sprint said that the prime credit mix of postpaid gross additions was the highest for a September quarter in the last seven years. Overall, the improvements in churn are particularly impressive since Sprint is the only large U.S. carrier to post a sequential improvement in the metric during the September quarter. [2] Low churn rates are important for wireless operators, since the cost of retaining existing subscribers is significantly lower than the cost of acquiring new subscribers.

Sprint’s progress on the billing front was also quite strong, with postpaid phone average billing per user growing by 2% year-over-year to $70.64, as higher installment billings and lease revenues helped to more than offset the lower service rates under the new device financing plans. Postpaid phone average billings per account also rose by 2% year-over-year to $166.  Notably, Sprint raised pricing on unlimited plans from $50 to $70, and the company indicated that it did not see demand for the plan drop despite the significant price increase. While the move should prove accretive to Sprint’s ARPU and margins effective immediately, it also inspires some confidence that the carrier’s pricing power is getting better, driven by the network improvements (related:Sprint Mulls The End Of Unlimited Data; How Could It Impact The Stock?). Although Sprint’s consolidated revenues continued to decline on account of subscriber losses in prior periods, we believe that an inflection point could be near, given the improving subscriber and billing metrics.

Network Improvements: Carrier Aggregation And Densification 

Sprint has been investing significantly to improve its network (cash capex projected at $5 billion in FY 2015) as it executes on a target of matching or exceeding rivals Verizon and AT&T in terms of network performance within two years. Through Q2, Sprint continued to deploy its two-channel (2×20 MHz) carrier aggregation technology, which now spans 80 markets across the country. Carrier aggregation combines non-contiguous bands of spectrum to enable better capacity and faster speeds, allowing carriers to make the most out of their available spectrum resources. Sprint says that there are now a total of 12 handsets, including the new iPhone 6S and 6S Plus, which support its carrier aggregation bands. Sprint is also working to expand and densify its network by upgrading its existing macro cell sites to support 800 MHz, 1900 MHz and 2.5 GHz for LTE, while also deploying thousands of new macro sites and tens of thousands of small cells, in a move that should help to improve capacity as well as coverage. The network improvements and optimizations seem to be paying off thus far, with independent mobile analytics firm RootMetrics indicating that Sprint’s median downlink throughput speeds improved by 66% year-over-year. This is quite notable, since data performance is an area where Sprint has lagged in the past. Sprint also has the lowest 4G LTE latency among U.S. carriers, according to a report from OpenSignal.

 Moderating Cash Burn With Restructuring Plan, Leasing Companies

Sprint has burned through over $2.3 billion in cash over the last six months, which is concerning given its high leverage (about $34 billion in debt). While the magnitude of the company’s debt maturities thus far has been modest ($1.1 billion due in FY’15 as of Q2), the company faces a sustained multi-year onslaught of large maturities (average $3 billion/year) that it will have to address beginning from fiscal 2016. [3] Since cutting back significantly on network spending is not really an option at this point, the carrier is attacking its operating cost base while also resorting to some financial engineering.

Sprint announced an aggressive restructuring plan that could see it achieve a sustainable reduction of $2 billion or more of run rate operating expenses in FY’16. This translates to roughly 10% of its operating expenses. While the carrier didn’t spell out the details, it noted that reductions will come from all areas of the business including labor costs, network operating expenses, information technology and administrative expenses. The company is also ramping up its distribution footprint in a cost-efficient manner, opening over 1,435 co-branded Sprint-RadioShack stores across the United States. Sprint is also expanding its “Direct 2 You” initiative, where an employee delivers and sets up a mobile device at a customer location.

Leasing now accounts for a bulk of Sprint’s device financing activity (51% take rate for Q2). Leasing has benefits for the carrier, since it allows it to capture the residual value of handsets as customers return them at the end of the lease. However, it hurts the company’s cash position as it pays vendors upfront for devices, while customers make lease payments on a monthly basis. However, Sprint is working with its parent SoftBank and others to establish a handset leasing company, which would effectively allow it to shift lease costs to a third party, freeing up cash for operations. The carrier expects to close the first tranche of the new lease facility within the next few weeks. Sprint is also expected to unveil a leasing vehicle for its network equipment after the handset vehicle is created.

Overview of Results And Guidance

  • Net operating revenues decreased 6% year-over-year to about $8 billion.
  • Net loss narrowed from a year ago, to $585 million, or $0.15 a share, from $765 million, or $0.19.
  • Wholesale net additions of 866,000 compared to 827,000 in the prior year quarter.
  • Sprint expects fiscal 2015 adjusted EBITDA at the lower end of its previous forecast of between $7.2 billion and $7.6 billion, due to restructuring costs relating to next year’s planned cost savings.
  • Reiterated $5 billion cash capex guidance, excluding the capex associated with purchasing leased devices in indirect channels.

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Notes:
  1. Sprint Q2 2015 Press Release []
  2. Sprint (S) R. Marcelo Claure on Q2 2015 Results – Earnings Call Transcript, Seeking Alpha, November 2015 []
  3. Quarterly Investor Update []